Appetite for destruction? Energy investors swap debt for equity

Energy investors deals often result in lower share prices

Energy investors

Energy investors exchange debt for equity in financially distressed firms like Chesapeake Energy Corp. photo.

By Jessica DiNapoli

NEW YORK, June 9 (Reuters) – Cash-strapped U.S. oil and gas companies, including No. 2 natural gas producer Chesapeake Energy Corp, are expected to cut their debt piles this year as a long-awaited rise in the price of oil persuades energy investors to swap bonds for stock.

Exchanging the debt of financially distressed firms for their equity can be a high-risk maneuver because shareholders are usually wiped out in the event of bankruptcy.

Also, a company’s share price tends to drop in the wake of these deals because they are usually agreed upon at a discount and the firms issue more shares for the swaps, diminishing the value of existing stock.

But investors doing these swaps in the U.S. energy market do not have an irrational appetite for destruction. Instead, they are often calling the shots, leaning on the desperation of companies to cut their debt, loaded up when oil was at $100 a barrel, as recently as 2014.

The companies are still bleeding cash even as oil has partly rebounded from a low of around $26 in February, to about $50 this week.

Besides these swaps, companies face few options other than bankruptcy to reduce their debt. Since early 2015, more than 60 oil and gas firms have sought court protection from their creditors.

The strategy of Hong Kong-based activist hedge fund Oasis Management Co Ltd is to buy an energy company’s bonds at deep discounts in the secondary market and then pitch the firm a deal to exchange them for equity, negotiating favorable terms for itself.

With its swaps, Oasis highlights that the companies also benefit by reducing their debt loads and cutting the amount they spend on interest.

“It’s a win-win,” said Alex Shoghi, a portfolio manager with the firm, referring to his potential profits and the companies’ chance to cut debt.

On paper, Oasis nearly doubled its money when it swapped $26.9 million in bonds at oil and gas explorer and producer Rex Energy Corp for 5.2 million shares of stock in April, according to public documents.

Bonds in the loss-making firm were trading at 12 cents on the dollar at the time, according to Thomson Reuters data, giving the debt a market value of just $3.2 million, while the shares Oasis received were worth $5.7 million.

It is unclear whether Oasis held on to its Rex stock, which has fallen by about 25 percent since the exchange. Shoghi declined to comment on the fund’s positions.

Rex declined to comment beyond public disclosures.

In a previous debt for equity swap, this time with Comstock Resources Inc, an oil and gas explorer with operations in Texas, Louisiana and Mississippi, Oasis moved quickly to sell the 4.6 million shares it had received in exchange for $40 million in debt.

Again, on paper, the trade netted Oasis double-digit returns. The fund had unloaded the bulk of the shares it received in the swap one month after it was announced, according to a public filing. Comstock shares tumbled by more than 50 percent over that time.

Shoghi declined to comment on Oasis’ trading.

Gary Guyton, director of planning and investor relations at Comstock, said Shoghi’s selling was “pretty orderly” and pinned the stock’s decline on other investors unloading their shares.

Swapping into shares may mean investors believe the company’s stock has upside. But the move can also be a way to exit an investment quickly, because equities are far more liquid than bonds, which can take days to sell.

After Oasis’ swap at Comstock, another investor exchanged $14.3 million in bonds for 2.6 million shares, which it then immediately sold, according to a person familiar with the matter.

“I think they’ll happen more,” Shoghi said. “We hope to continue to be a market participant.”

Indeed, shareholders at Rex and Comstock have approved the authorization of millions more shares of common stock, a sign of possible future exchanges.

The negotiations on the terms of future deals may change as bond and share prices rise to reflect the recovery in oil prices. Oasis’ deals were done when bonds were deeply distressed.

Guyton said further exchanges were possible, and that Comstock had received offers from other investors looking to swap debt for shares.

“We put out the press release talking about the first one and then our phones started ringing off the hook,” he said. “We found out basically there’s some cottage industries out there that do this for a living. They’re looking for debt-for-equity swaps.”


Including the swaps at Rex and Comstock, oil and gas companies have completed more than a dozen debt-for-equity swaps over the past 14 months, clearing out more than $1 billion in debt.

To be sure, that is just a drop in the ocean – U.S. oil and gas companies sold about $350.7 billion in debt between 2010 and 2014, the peak years of the oil-and-gas boom, when oil prices were peaking.

With the recent crash in prices, consulting and auditing firm Deloitte expects about one-third of U.S. oil producers to file for bankruptcy this year.

The debt for equity swaps, which center on bonds not backed by collateral, can at least help ease the burden.

“If your balance sheet forces you into bankruptcy, your equity is worth zero,” said Marisa Moss, an analyst at Citigroup. “So would you rather do debt for equity, be diluted, but live to see another day? I think the answer is yes.”

Chesapeake Energy has completed four debt-for-equity swaps since March, eliminating more than $500 million from its approximately $9 billion debt pile.

The exchanges target the approximately $2.5 billion the company could have to pay out in 2017 and 2018.

“This is a great way to clear that maturity wall,” said Moss.

Chesapeake declined to comment. Its shareholders have also approved the authorization of millions more shares of common stock, potentially for future exchanges.

Bill Barrett Corp, which explores and develops oil and natural gas properties in the Rocky Mountains, swapped $84.7 million in notes for equity late last month. Bucking the trend, the company’s shares rose after the deal.

But swaps are not a panacea for financial distress.

Halcon Resources Corp cut more than $250 million in debt last year exchanging notes for equity with investors including Goldman Sachs Asset Management LP and JP Morgan Securities LLC.

The swaps may have helped buy the company more time before facing bankruptcy, but did not save it in the long run. Halcon announced a restructuring deal last month and plans to file a prepackaged bankruptcy.

Both Goldman Sachs Asset Management and JP Morgan Securities had nearly eliminated their holdings of Halcon shares as of March 31, according to Thomson Reuters data. It was not possible to determine if either money manager booked profits or losses on their deals.

Halcon did not immediately return requests for comment. Goldman Sachs and JP Morgan declined to comment.

(Editing by Carmel Crimmins and Matthew Lewis)

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